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Senator Gravel, FairTax, and taxation in Pakistan

Senator Gravel, one of the Democratic presidential candidates, has been making some noise online recently. It’s pretty funny — I watched Robin Williams’ Man of the Year two days ago, and then yesterday, the video below was featured on Reddit. As you can see, Gravel does the closest impersonation of Williams’ character possible without losing credibility.

One of the things Gravel’s proposing is to implement FairTax, a system that does away with traditional income tax and instead applies additional duties to goods and services. It’s not quite revolutionary in that other forms of tax, such as highway tolls and the congestion charge here in London, are already applied on a per-use basis, but it has some pretty cool effects.

The first thing to notice is that, under the scheme, the additional tax is collected from producers, not retailers or consumers. This means the tax base shrinks immediately, which is good because it makes tax evasion harder and the process more transparent. In addition, the cost of collecting revenues falls dramatically.

The second thing is that a flat tax applied to goods and services (assuming it’s flat — we’ll get to that in a minute) makes it almost impossible for special-interest groups and lobbyists to try to have the tax regime biased in favour of the rich or the organised. This isn’t a serious problem in Pakistan, but it’s nice to have.

Thirdly, the scheme ties revenue generation to consumer spending, rather than earnings, which probably has significant implications for inflation. At the very least, it encourages savings, which is a good thing, particularly in a credit-hungry country like the US.

It’s a little unclear to me whether a flat tax on all goods and services would be a good thing. The argument that it’s fairer doesn’t really hold water, since luxury goods that are consumed only by the rich would raise the tax rate for everyone. Consequently, a tiered tax rate might make more sense. The scheme includes the notion of pre-bates to relieve unfair burden from the ultra-poor, which sounds like a good idea.

I have read, though, that the ratio of spending between the rich and the poor is approximately the same as the ratio of earning between the rich and the poor, which would mean that the gulf between rich and poor wouldn’t be bridged in any way by this scheme. That actually sounds fair enough to me, since the point of taxation isn’t to artificially redistribute wealth (which would invariably lead to inflation).

My interest in this, of course, relates to taxation in Pakistan. The two big problems we face are ridiculously high levels of tax evasion and a culture of kickbacks and corruption.

The former, it is often said, is difficult to tackle simply because much of Pakistan’s economic activity is unrecorded. This doesn’t imply a lot of black market activity, but rather just that smaller retailers don’t maintain records that can be easily examined. The government has resorted to increasingly lax policies to fix the situation, including a recent one which promises that tax returns, no matter how absurd, will not be disputed by the government. There’s no guarantee this will work, of course: some people claim the reason economic activity isn’t recorded is illiteracy. It’s obvious how a system like FairTax would be useful here: the government would no longer have to worry about tracking down and auditing every small retailer (and all his employees), since it would only deal with the producers supplying the retailers with goods.

The problem of corruption would also be addressed, since the scheme is far more transparent and enforceable than filing returns. In effect, you pay tax every time you buy an item, whether it be a sandwich or a Mercedes. There is simply no reason left to slip envelopes to tax officials.

There are other benefits of FairTax that I have not discussed, for example that the overall tax burden over an average lifetime is much reduced under the scheme. Clearly, it is a promising idea and given the failure of our current tax regime, it might be one worth considering.